‘Flash Crash’ Panel Lays Out Several Steps to Diminish Volatility in the Market

A committee set up in response to the “flash crash” of the stock market last May said on Friday that regulators had done much to address the blow to investor confidence but had not yet done enough. It also set out additional steps, including tightening controls on the growing number of computerized high-frequency and algorithmic traders.

The committee, a joint effort by the Commodity Futures Trading Commission and the Securities and Exchange Commission, includes top academics and market experts like Brooksley E. Born and the Nobel Prize-winning economist Joseph E. Stiglitz. It was set up to advise regulators after the sharp fluctuation in the stock market on May 6, 2010, when the Dow Jones industrial average plunged more than 600 points in a matter of minutes before recovering just as quickly.

The committee’s report said the growing dominance of high-frequency and algorithmic traders had made markets fragile and emphasized the increased interconnectedness between equities and derivatives markets, which could transfer sharp swings in one market to the other almost instantaneously.

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Joseph Stiglitz, a Nobel Prize winner, is a member of the joint committee.Credit
Stephen Yang/Bloomberg News

“We cannot overstate the importance of addressing the most pressing issues here,” the advisers said in the report. “While many factors led to the events of May 6, and different observers place different weights on the impact of each factor, the net effect of that day was a challenge to investors’ confidence in the markets.”

In putting forward 14 recommendations of its own, it praised some of the measures imposed by regulators since the flash crash, like circuit breakers for individual stocks, which pause trading if a stock moves wildly, and moving toward a consolidated audit trail to give common information about trading across different stock exchanges.

But it also offered up some blunt criticism, saying that in the future regulators had to be more forward-looking and to act quickly before big market crashes, rather than afterward.

It said the circuit breakers should be extended beyond stocks included in the Russell 1000 stock index to encompass all actively traded stocks and exchange-traded funds. It said the circuit breakers might be replaced by so-called limit up/limit down procedures, which limit trading in a stock beyond certain price limits.

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Brooksley Born, a market expert, is also a member.Credit
Andrew Harrer/Bloomberg News

The report raised questions about the practice of “co-location,” in which some computerized traders gain advantage by moving their machines next to the stock exchange’s own computers, thus cutting trading time down to fractions of a second. The committee said it supported a clampdown on “naked access,” when unregulated traders are sponsored by a broker to gain access to a market.

It said there should be closer scrutiny of high-frequency traders that use their rapid-fire trading strategies to disrupt markets and said authorities might consider charging fees to traders who send off thousands of orders a second, only to cancel them a moment later. Some high-frequency traders use these “order cancellation” strategies to glean information about the market and their rivals.

The report worried about declining numbers of buyers and sellers in public markets and said there was a lack of obligation among high-frequency traders to stay in equity markets when they became volatile. It said regulators should consider incentives or rules to force high-frequency traders to remain as buyers or sellers.

It also said regulators had to look again at the implications of the growing trend for trading to take place away from public exchanges. One-third of all stock market trading is now executed in so-called dark pools, it said.

A version of this article appears in print on February 19, 2011, on Page B7 of the New York edition with the headline: ‘Flash Crash’ Panel Lays Out Several Steps to Diminish Volatility in the Market. Order Reprints|Today's Paper|Subscribe